It appears that the SEC has declared war on those who trade on insider information. A recent case highlights the potential problems companies, particularly those in the pharmaceutical industry, face during clinical trials for new products.
In early November, the SEC brought an action for insider trading against a physician involved in an investigational drug clinical trial based on the alleged use of confidential information about the clinical trial disclosed by the physician to a hedge fund portfolio manager. The Department of Justice also initiated parallel criminal proceedings for securities fraud based on the same allegations. The charges by the agencies reflect a more aggressive response by the SEC and other federal law enforcement agencies to alleged acts of insider trading as well as a new focus on the growing number of medical professionals that act as consultants to Wall Street investors.
If the SEC and DOJ are successful, the case could have significant implications for: hedge fund managers and other investors working with consultants from the medical community; pharmaceutical and medical device manufacturers testing new products in clinical trials; and physicians and other third parties involved in the conduct of clinical trials. Even if the SEC and DOJ are not ultimately successful, the existence of the case warrants a reconsideration of relationships among investors, manufacturers and third parties involved in clinical trials.
A French physician, Yves M. Benhamou, M.D., was charged with unlawfully providing confidential information regarding disappointing clinical trial results to a hedge fund portfolio manager. The charge is based on allegations related to the physician’s involvement as a consultant and lead investigator for clinical trials conducted by Human Genome Science, Inc. The clinical trials involved a new drug then known as Albuferon that the company was developing for the treatment of chronic hepatitis C. According to the allegations, Dr. Benhamou was a member of a five person steering committee overseeing the Albuferon clinical trial. The physician was also the “country lead investigator” for France and other parts of Europe. While acting in these capacities, Dr. Benhamou was also retained as a consultant by a portfolio manager, who was managing portfolios of health care hedge funds that, during the period in question, owned approximately six million shares of HGSI. The SEC alleges that Dr. Benhamou alerted the portfolio manager about a setback in the clinical trial. This occurred several days before HGSI’s public announcement of the issues with the trial. In response to the tip, the hedge funds allegedly sold their HGSI positions, avoiding nearly $30 million in losses.
Making the Case or Cases
Observers believe that there may be potential issues with the specific allegations in this case, the case nonetheless highlights an overlooked legal risk for physicians and other third parties involved in clinical trials who have access to confidential information. Most notably, physicians and other medical professionals who serve in roles like Dr. Benhamou should be aware of what information may be used when serving as Wall Street consultants and what information should be kept confidential to avoid insider trading liability. To minimize insider trading risk, other third parties involved in clinical trials may want to review their policies and procedures for communicating to personnel, and enforcing compliance with, confidentiality provisions in agreements with manufacturers conducting clinical trials. In particular, if a clinical site contracts with a manufacturer on behalf of an investigator, the site may want specific assurances from the investigator that confidentiality obligations will be satisfied. In the wake of the Dr. Benhamou case, third parties should also be ready to respond to requests from manufacturers for enhanced confidentiality protections and know what they can reasonably accept.
So far, no charges have been filed against the hedge funds that allegedly traded based on the information received from the physician, the investment advisers to those funds, or the portfolio manager that received the alleged tip. However, the SEC complaint states that the portfolio manager knew or should have known that the doctor was providing him with information in breach of a confidentiality obligation. According to the SEC complaint, the portfolio manager knew or should have known of the breach even though the doctor agreed not to provide the portfolio manager with confidential information. The manager’s awareness of the doctor’s breach is allegedly based upon his awareness that the doctor “served on the trial’s Steering Committee and owed a duty of confidentiality to HGSI.”
What About Reg. FD?
Members of the investment community that hire such consultants need to be aware that their industry experts could be basing their opinions on confidential information and that simply having a contractual clause with the consultant requiring them not to pass along confidential information may not be enough to avoid insider trading liability. This risk is particularly acute when the consultant is in a close relationship to the issuer, including current or former employees of the issuer.
Hedge fund advisers and other professional investors may want to consider adopting or reviewing policies regarding the use of industry consultants. Such policies may require that portfolio managers and other investment personnel remind consultants of their obligation not to pass along confidential information at the outset of each contact, and that compliance staff monitor conversations between investment personnel and consultants.
Thus far, no allegations have been filed against Human Genome, nor does either of the government’s complaints allege any wrongdoing by the company. However, it is of interest that HGSI asked the physician to sign a new confidentiality agreement two days after the announcement of the problems encountered in the clinical trial. This may have occurred because of concerns about Reg. FD.
Physician Heal Thyself
This case highlights the need for pharmaceutical companies conducting clinical trials to enhance protection of the confidential information available to the broad range of third parties who assist in the conduct of clinical trials. Such companies may also want to review their standard confidentiality provisions in clinical trial agreements and consider whether those provisions could be strengthened. In their agreements, pharmaceutical companies may want to include an acknowledgement that outside parties involved in the conduct of the clinical trial may be “insiders” who have gained material, nonpublic information about the clinical trial as a result of that involvement. Such agreements could also prohibit outside parties from engaging in transactions (or advising others to do so) involving manufacturer stock until the clinical trial results are public. Finally, outside consultants should be made to disclose their relationships with financial advisors as part of their agreements.